Where next for the Euro, the ECB and the Euro area economy?

In our new financial world where pretty much everything depends on the whims and moods of central bankers one of the main leaders is the ECB or European Central Bank. Yesterday we got one version of its future from the Governor of the Bank of Finland Ollie Rehn. So let me hand you over to his interview with the Wall Street Journal.

“It’s important that we come up with a significant and impactful policy package in September,” said Mr. Rehn, who sits on the ECB’s rate-setting committee as governor of Finland’s central bank.

“When you’re working with financial markets, it’s often better to overshoot than undershoot, and better to have a very strong package of policy measures than to tinker,” Mr. Rehn said.

That is pretty cleat although there is are two self-fulfilling problems in trying to overshoot financial markets. The first is that you are devolving monetary policy to financial markets. The second is that markets will now adjust ( they did so yesterday as I will discuss later) so do you overshoot that as well?

According to the WSJ these are the expectations Ollie was trying to overshoot.

Analysts expect the ECB will announce next month a 0.1 percentage-point cut to its key interest rate, currently set at minus 0.4%, as well as around €50 billion ($56 billion) a month of fresh bond purchases under its quantitative easing program. The program had previously been phased out at the end of last year.

There is already an example of the “slip-sliding away” as Paul Simon would put it that I mentioned earlier as the monthly bond purchases were expected to be 30 billion Euros a month. So which one would Ollie be overshooting?

Even worse for hapless Ollie others seem to have a different set of expectations.

Investors currently expect the ECB to cut its key interest rate to minus 0.7% and to hold rates below their current level through 2024, according to futures markets. Mr. Rehn said those market expectations showed that investors had understood the ECB’s guidance.

So will he now be overshooting -0.5% or -0.7%? Actually it gets better as -0.6% is in there now as well.

The comments suggest the ECB might cut interest rates by more than expected in September, perhaps by 0.2 percentage points, and could start to purchase new types of assets, Mr. Ducrozet said.

So roll up! Roll up! Place your bets on what Ollie will be trying to overshoot. Also as no doubt you have spotted whilst he may be in Finland he wants to start turning Japanese.

Mr. Rehn said he didn’t rule out a move to purchase equities under the QE program, but that would depend on the assessment of ECB staff.

That is a pretty shocking as the ECB staff assessment will be exactly what the Governing Council wants in the manner explained by The Jam.

You want more money – of course, I don’t mind
To buy nuclear textbooks for atomic crimes
And the public gets what the public wants

As I have acquired quite a few extra followers in the last week or two let me explain the Japan reference which is that the Bank of Japan has for a while now been purchasing Japanese equities. According to its latest accounts it now holds 26.6 trillion Yen of them.

The Problem

It is highlighted by this.

To provide space for fresh bond purchases, the ECB could adjust the rules of its bond-buying program, which currently prohibit the bank from buying more than 33% of the debt of any individual eurozone government, he added.

This is an example of what ECB President Mario Draghi calls it being a “rules-based organisation”. It is until they are inconvenient and then it changes them! One of the ways it got support for the previous QE programme was the limit above bit now it will be redacted from history. How high can it go? Well one example is from my own country the UK where the Bank of England does not have country limits ( for obvious reasons) but it does have a limit of 70% for each individual Gilt-Edged bond.

The Euro

Part of the plan behind Ollie’s interview was to talk down the Euro. After all the new “currency war” style consensus is to try a grab a comparative advantage in a zero-sum game. In a small way he succeeded as the Euro fell against most currencies. But there is a catch as highlighted by this release from Eurostat today.

As a result, the euro area recorded a €20.6 bn surplus in trade in goods with the rest of the world in June 2019…….In January to June 2019, euro area exports of goods to the rest of the world rose to €1 163.3 bn (an increase of
3.2% compared with January-June 2018), and imports rose to €1 061.2 bn (an increase of 3.7% compared with
January-June 2018). As a result the euro area recorded a surplus of €102.2 bn, compared with +€103.6 bn in
January-June 2018.

As you can see in the first half of the year trade created a demand for the Euro of around 102 billion Euros which is a barrier against any sustained fall. Actually this is a German thing because if you look at the national breakdown it accounts for 112 billion of this. Other nations such as the Netherlands run large surpluses assuming we look away from the “Rotterdam Effect” but as a collective in a broad sweep they contribute very little. So we get something very awkward which is that the main exchange rate fall came when Germany switched the Dm to the Euro. Since then there has been a lot of hot air on the subject but in terms of the effective exchange rate the Euro is at 98.3 or a mere 1.7% from where it started.

In a purist form I should look at the full current account but hopefully you have the idea from the trade figures. Partly I am doing that because I have very little faith in the other numbers.

Even more awkward for the ECB would be a situation where President Trump actually goes forward with his plan to buy Greenland. He would pay Denmark in its Kroner but as it is pegged to the Euro this would raise the Euro versus the US Dollar which is presumably part of the plan.

Comment

There is a lot to consider here but let me open with looking at the real economy. It is struggling with some but not much growth. So far in 2019 economic growth has gone 0.4% and then 0.2% on a quarterly basis. The fear is that it will slow further based on what was a strength above ( Germany’s trade surplus) which right now looks a weakness or as Frances Coppola out it.

Thread. Germany has been importing demand from China for a long time.

I am not saying it is the only perspective but it is one. On this road we have found little economic growth because even if we take the view of Mario Draghi this created a mere 1.5% of extra GDP growth. On the other side of the ledger is the destruction wreaked on all long-term contracts such as pensions and bond markets by the world of negative interest-rates. Oh and the fact if it had worked we would not be here.

As to the real economy well if we return to Ollie we see that in fact his main concern is “The Precious! The Precious!”

To offset the impact on eurozone banks of a longer period of negative interest rates, the ECB could introduce a tiered-deposit system, under which only a portion of bank deposits might be subject to negative rates, Mr. Rehn said.

The ECB could also alleviate the stress on banks by sweetening the terms of new long-term loans, known as targeted longer-term refinancing operations, he said.

If the real economy merits a mention I will let you know….

As a final point this version of economic management combining “open mouth operations” with reading a Bloomberg or Reuters screen to see where markets are often involves what have become called “sauces” saying something different, so be on your guard.

Meanwhile liuk on twitter has a suggestion which we can file under QE for millennials.